The bond markets have priced in the “Economists”
I’ve frequently argued that the Great Recession was caused by macroeconomists, not bankers. Ryan Avent found a gem that perfectly illustrates my hypothesis:
A remarkable piece in the [2006] New York Times commented:
“Economists applauded the Bank of Japan’s interest rate increase, the first in six years, as a long-awaited signal that Japan’s $4.6 trillion economy is finally getting back on track.
They said that by moving pre-emptively on Friday, long before a return of inflation is likely to became a threat, the central bank was also hoping to demonstrate that it was watching prices carefully, and was therefore up to the task of stewarding Japan’s economy, the world’s second largest after the United States.”
I wish they would have named the “economists” who were applauding. I’d guess they were the same ones who applauded when the Fed raised rates in 1937, only to drop them to zero again in 1938. And when the BOJ raised rates in 2000, before cutting them back to zero in 2001. And when the ECB raised rates last spring, before cutting them again a few months later. And they’ll be applauding when the Fed raises rates prematurely.
All one needed to do was look at the Japanese bond market to know that inflation was not just around the corner.
The US bond markets have also priced in the pernicious influence of these unnamed economists. Ten year bonds yield about 1.5% and the 30 year bond yields about 2.6%. That can only mean one thing; the bond market expects low NGDP growth for as far as the eye can see. They understand that any pickup in NGDP growth would lead the Fed to tighten, and we’ll drop right back into the slow growth track.
Woodford showed that current AD is determined by future expected monetary policy. Because the median economist in America, Japan and Europe has a flawed model of the economy, they will continue to enact bad policies. The expectation of those future bad policies causes AD to be low right now.
You’d think that there would be soul-searching among the “economists” who applauded the BOJ awful 2006 decision. But don’t count on it. Their view of reality is flawed. Indeed I’d wager that the mistake that seems obvious to Ryan and I, doesn’t even register in their consciousness. I’m sure they sleep comfortably at night, while I toss and turn thinking about where we are headed.
Update: Commenter Johnleemk sent me this list, which is just a tiny percentage of the economists who either think money is too easy, or about right. It’s from 2010, so we already know they were completely wrong. Perhaps someone could check to see how many have admitted to being wrong in 2010.
To: Chairman Ben Bernanke Federal Reserve Washington, DC
Dear Mr. Chairman:
We believe the Federal Reserve’s large-scale asset purchase plan (so-called “quantitative easing”) should be reconsidered and discontinued. We do not believe such a plan is necessary or advisable under current circumstances. The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment.
We subscribe to your statement in The Washington Post on November 4 that “the Federal Reserve cannot solve all the economy’s problems on its own.” In this case, we think improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus.
We disagree with the view that inflation needs to be pushed higher, and worry that another round of asset purchases, with interest rates still near zero over a year into the recovery, will distort financial markets and greatly complicate future Fed efforts to normalize monetary policy.
The Fed’s purchase program has also met broad opposition from other central banks and we share their concerns that quantitative easing by the Fed is neither warranted nor helpful in addressing either U.S. or global economic problems.
Respectfully,
Cliff Asness AQR Capital
Michael J. Boskin Hoover Institution, Stanford University Former Chairman, President’s Council of Economic Advisors
Richard X. Bove Rochdale Securities
Charles W. Calomiris Columbia University Graduate School of Business
Jim Chanos Kynikos Associates
John F. Cogan Hoover Institution, Stanford University Former Associate Director, U.S. Office of Management and Budget
Niall Ferguson Harvard University Author, The Ascent of Money: A Financial History of the World
Nicole Gelinas Manhattan Institute & e21 Author, After the Fall: Saving Capitalism from Wall Street””and Washington
James Grant Grant’s Interest Rate Observer
Kevin A. Hassett American Enterprise Institute Former Senior Economist, Board of Governors of the Federal Reserve
Roger Hertog Hertog Foundation
Gregory Hess Claremont McKenna College
Douglas Holtz-Eakin Former Director, Congressional Budget Office
Seth Klarman Baupost Group
William Kristol Editor, The Weekly Standard
David Malpass GrowPac, Encima Global Former Deputy Assistant Treasury Secretary
Ronald I. McKinnon Stanford University
Joshua Rosner Graham Fisher & Co., Inc.
Dan Senor Council on Foreign Relations Co-Author, Start-Up Nation: The Story of Israel’s Economic Miracle
Amity Shlaes Council on Foreign Relations Author, The Forgotten Man: A New History of the Great Depression
Paul E. Singer Elliott Management Corporation
John B. Taylor Hoover Institution, Stanford University Former Undersecretary of Treasury for International Affairs
Peter J. Wallison American Enterprise Institute Former Treasury and White House Counsel
Geoffrey Wood Cass Business School at City University London
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13. July 2012 at 07:19
Someone pointed out the other day that the 20 Yr TIPS yield had hit zero (it’s above that a bit now). I interpret that to mean the market expects a real return on assets over the next 20 years of 0%! http://research.stlouisfed.org/fredgraph.png?g=8IL
13. July 2012 at 07:21
It’s also scary how many investors managing large sums of money are on that list. As another example, here’s David Einhorn, who is by all accounts a great investor and manages billions, railing against the Fed’s “easy money” in a recent oped in the Huffington Post:
“Some will argue that if the Fed raises rates, it will cause deflation … The sort of deflation that puts pressure on wages is a clear negative, as it leads to a lower standard of living. On the other hand, lower prices caused by scientific progress and higher efficiency are unambiguously positive.
Apple’s newest iPhone has twice the memory, a better camera, and other small improvements and carries the same price as the prior version. Government statisticians see an improved product at the same price and count it as a price cut, or deflation.
There is no reason for the Fed to conduct monetary policy to offset advances that improve our standard of living, in particular when it results in driving up the price of something else, like oil.”
13. July 2012 at 07:26
Remember how a commodity shock in oil in 2008 delayed badly needed Fed action in 2008? Well don’t look now because something similar could happen this summer with the midwest drought. It is already causing a whole range of crop prices to shoot up. I think this is why today’s PPI reading came in quite a bit above expectations. This supply shock combined with the Fed’s uncertainty about the effectiveness of its monetary policy tools may delay needed action later this summer and fall. I doubt we will see a crash like 2008, but things could get dicey.
The market hasn’t dropped much right now because it is frontrunning the Fed and fully anticipating QE3. If there is any whiff that QE3 might be delayed, watch out below.
13. July 2012 at 07:37
A lot of the people on that list of signatures aren’t even economists. I think it’s a bit unfair to indict the entire profession, rather than merely that subset, based on that.
13. July 2012 at 07:39
I wish they would have named the “economists” who were applauding. I’d guess they were the same ones who applauded when the Fed raised rates in 1937, only to drop them to zero again in 1938.
Those are some old economists.
13. July 2012 at 07:50
There are old economists and there are bold economists, but there are no old, bold economists.
13. July 2012 at 07:58
I don’t know if 10 yr bonds necessarily indicate indicate an expectation of long term inflation @ 1.5%. It could also indicate that the market is expecting the Fed to buy more 10 year bonds at a premium in the near future and someone else will be left holding the bond if inflation picks up.
13. July 2012 at 08:01
Scott and MP, Good points.
Wonks, You said;
“A lot of the people on that list of signatures aren’t even economists. I think it’s a bit unfair to indict the entire profession, rather than merely that subset, based on that.”
More than a bit unfair, it would be absurd to indict the entire profession based on a list like that. Most economists probably don’t currently favor either easier or tighter policy, they are happy with current Fed policy. But they are also part of the problem!
Josiah, I was thinking that when I wrote it, but plunged ahead anyway.
13. July 2012 at 08:03
Sam, I agree that bond yields don’t tell us the rate of inflation, they are more closely linked to NGDP growth. The TIPS spread shows about 2% inflation over the next 10 years, although I think that partly reflects tail risk, it’s likely to be under 2%.
13. July 2012 at 08:07
I don’t like to put things in such stark terms, but economists — if you’re not part of the solution (i.e. putting yourself out there, telling everyone that macro 101 recommends looser money — Betsey Stevenson and Justin Wolfers being a couple good recent examples here), you are part of the problem.
By remaining silent, you are endorsing extraordinarily tight money that has led to simultaneous 1% headline inflation and extraordinarily high unemployment over the last 4 years. No sane person can reconcile this with the basic macro you teach throughout the world. It makes no sense in the AS-AD model.
If you aren’t pointing out a basic macro 101 mistake which policymakers across the developed world are committing, you’re part of the problem.
13. July 2012 at 08:14
So, did you express disapproval of the BoJ’s action in 2006, Scott? I am sure I approved of it at the time, because the global economy was booming in 2006, and the BoJ had built up a large stock of bank reserves which might have posed an inflation risk had the boom continued.
And, while I do not agree with the politics of some of the signatories to the 2010, they have not proved to be wrong. It is still not clear that it will be possible to unwind QE without either generating renewed contraction or high inflation, and the alternative of real economic reforms in tax, spending and regulation that was called for has not been seriously tried.
13. July 2012 at 08:18
ssumner:
The US bond markets have also priced in the pernicious influence of these unnamed economists. Ten year bonds yield about 1.5% and the 30 year bond yields about 2.6%. That can only mean one thing; the bond market expects low NGDP growth for as far as the eye can see.
It’s truly remarkable (and rather funny) that in your worldview of the determinants of bond prices, and hence yields, you are led into believing that the (historically low) 1.459% yield on 10 year bonds means bond investors expect low NGDP growth for 10 years.
Much like your confusion regarding the determinants of TIPS yields and yield spreads, it apparently spills over into vanilla bond yields as well.
In a word, the vanilla bond market is as complex as the TIPS bond market, so you cannot make these pedantic and crude inferences from the yields. Your treatment reminds me of a Keynesian who is blinded into believing that the only thing historical data can show is confirmation of the efficacy of Keynesian stimulus if times are good, and not enough Keynesian stimulus has taken place if times are bad.
There are many possible reasons for why 10 year bond yields fetched 1.459% a couple days ago, none of them being “low NGDP growth”, which virtually no investor even looks at anyway!
First, some background facts. The bid to cover ratio was 3.61, which was the second highest in history, second only to April 2010. The Primary Dealer take was 14%, with a hit rate of 6.8%, a record low. Direct Bidders took 45.4%, a record high. There is something going on here, besides the bond markets allegedly proving your worldview right concerning NGDP.
Why would direct bidders take an incredible 45.4% of all the bonds, and pay what seems like a money is no object price? Could some institutions somewhere have a desperate need for collateral for a margin call? Could European investors have needed them because of problems in Europe? Were there investors trying to cover shorts? Are bond investors front running the Fed, which is a pattern that has become more and more prevalent (see the NY Fed’s recent report of how 80% of the S&P500 returns since 1994 have come before and during FOMC announcements)?
All these reasons above are completely within the bounds of possibility, and none of them have to do with pricing in allegedly low NGDP growth for 10 years.
Seriously, if your worldview leads you to concluding that bond market investors “expect low NGDP growth for as far as the eye can see” (I mean really, you actually believe investors actually think that Fed chairmen 20 to 25 years from now, who probably haven’t even started their PhD program yet, are going to preside over low NGDP growth? You actually believe investors are pricing in that expectation?
Am I sure glad I don’t adhere to NGDP fetishism like you. It leads one into veritable la la land.
13. July 2012 at 08:28
Ron McKinnon should be ashamed of himself. The rest are mostly Republican whores, but he’s a first-rate economist who should know better.
13. July 2012 at 08:31
It is interesting how many of the economists who were signatories are at the Hoover Institution. An institution named after a President who got things very wrong and had the worst economic record in history is likely to attract people who get things badly wrong too.
13. July 2012 at 08:34
“Mr. SpockYour comment is awaiting moderation.”
OOOps! Forgot to change the name and e-mail address before posting this message. Here is my reposting:
It is interesting how many of the economists who were signatories are at the Hoover Institution. An institution named after a President who got things very wrong and had the worst economic record in history is likely to attract people who get things badly wrong too.
13. July 2012 at 08:44
Many who signed that letter to Bernanke are NOT economists!
13. July 2012 at 08:59
Major Freedom,
You are right that government bond investors do not think about nominal GDP growth, but as a former Government bond investor, I can tell you that they spend a lot of time thinking about real GDP, inflation, and the next move from the fed. Fed action more than a year out is too uncertain for most Goverment bond investors to think about.
Scott,
In the first half 2010, the markets were priced for a quick rebound out of the recession. By the end of that year, it sentiment had turned. It doesn’t make the signatories to this letter less wrong, but it does not show them out of step from the market.
As for what the market is pricing now, I don’t think the 10 year note is the good indicator of market expectations of Fed funds movements. Look at Eurodollar futures instead. Eurodollars are priced for no change in Fed funds through 2014, and only a moderate probability of tightening through 2015.
13. July 2012 at 09:01
Richard A.,
And many of them were. So what? Ryan Avent, Matt Yglesias, and Matthew O’Brien are prominent sympathisers/advocates of market monetarism, and they aren’t economists. That hardly discredits the case for market monetarist ideas. The point is that a scary number of economists, including John Taylor — the guy who almost literally wrote the modern textbook on monetary policy — signed onto that nonsense.
13. July 2012 at 09:19
Doug M:
You are right that government bond investors do not think about nominal GDP growth, but as a former Government bond investor, I can tell you that they spend a lot of time thinking about real GDP, inflation, and the next move from the fed.
As a former government bond investor and current portfolio manager, I can tell you they also spend a lot of time thinking about, and are likely even more concerned about, their own particular individual circumstances and their own particular markets. It is these factors that are being completely overlooked with the claim “Bond investors expect low NGDP growth for as far as the eye can see.”
I mean really, how bad is one’s worldview when one is compelled into saying that bond investors expect (without even finding out what their reasons are first) a low NGDP growth 15, 20, 25, 30 years out, and that’s allegedly why they priced the bonds so high in the present?
Where are the micro-economic factors? Where are the possible subjective preferences and exigent circumstances? I feel like I’m reading a home builder who believes every problem in the house can be solved by using the same hammer with the letters “NGDP leveler” printed on it.
Fed action more than a year out is too uncertain for most Goverment bond investors to think about.
I know. Tell that to Sumner. He just claimed investors are pricing in Fed policy 15, 20, 25 years out.
13. July 2012 at 09:31
Mr. Spock = Full Employment Hawk = names that end with the sound of “OCK.”
Hmmmm….LOL
13. July 2012 at 09:32
“including John Taylor “” the guy who almost literally wrote the modern textbook on monetary policy “” signed onto that nonsense”
Earlier in his career, Taylor made important contributions to the field. He was one of the original contributors to the development of the New Keynesian Economics, among other things. But he has now deteriorated into a right-wing ideologist.
13. July 2012 at 09:37
I only used the Mr. Spock nickname in one place because I wanted to label one especially wrongheaded comment the way Mr. Spock of Startreck would have labeled it: IRRATIONAL AND ILLOGICAL.
13. July 2012 at 09:41
Earlier in his career, Taylor made important contributions to the field. He was one of the original contributors to the development of the New Keynesian Economics, among other things. But he has now deteriorated into a right-wing ideologist.
People change.
Interestingly, John Taylor the changing man is proof that John Taylor’s epistemology and his “Rule”, both of which presuppose constancy in human knowledge and action, are necessarily wrong.
How’s that for irony?
13. July 2012 at 09:45
Scott, you need to read the speech Dennis Lockhart gave today. http://goo.gl/g0EeM
Lockhart basically sums up the things the FOMC is currently deliberating about. Here is my take.
First, there are two schools of thought: (1) the current outlook “calls for further policy action now or before too long” and (2) further aggressive monetary stimulus “should be held in reserve to respond to a sharp further deterioration in the outlook.” The latter is clearly Lacker’s position (and probably Kocherlakota’s and Fisher’s, but they don’t vote so we can’t see their dissents like we can Lacker’s).
The sub-issues that inform this big issue are: (1) the extent of the output gap (how far GDP is from its potential), (2) size of the Fed’s balance sheet, and (3) the effectiveness of further monetary policy.
Some members believe the output gap is large and others believe there is no output gap. Some members worry that increasing the size of the Fed’s balance sheet raises concerns about future inflation and that those risks are potentially uncontrollable and others believe the opposite. Some members believe further monetary policy will not make a difference because interest rates are already low and the economy isn’t expanding.
Lacker comes down on the side of more stimulus now “if the economy continues on the track indicated by the most recent incoming data and information.”
13. July 2012 at 09:49
Because the median economist in America, Japan and Europe has a flawed model of the economy, they will continue to enact bad policies. The expectation of those future bad policies causes AD to be low right now.
well, sort of: the median economist on the FOMC has a flawed model and does not pay attention to the markets. Based on TIPS, consumer and business surveys, etc, i would say the median economist has it just about right.
maybe where the median economist goes wrong is they mis-estimate the incentives of the Fed. you know, its very hard to judge the influence of incentives when you have an agency problem and incentives are mis-aligned. me, i see incentives everywhere. The median FOMC gets paid whether they do a good job or not (i.e. implement the mandate). not surprisingly, more than a fair share are lazy and overly influenced by other-than-mandate factors (i dare say, politics).
post your monthly FOMC scorecard, we are still doing badly! post it until people start to realize “hey, the FOMC really sucks at their job.”
13. July 2012 at 11:02
Scott N,
“Remember how a commodity shock in oil in 2008 delayed badly needed Fed action in 2008?”
No, I don’t. Fed cut the short term rate 3.25% between 9/07 and 4/08, and 1.75% post Lehman.
“Well don’t look now because something similar could happen this summer with the midwest drought. It is already causing a whole range of crop prices to shoot up.”
This is why most Fed watchers talk about core inflation. It is assumed that the Fed cares wage inflation and a general rise in the price level, and not about the supply shock. In fact I see more people take the other side of this. The Fed should ease into supply shock of this nature to offset the negative income effect of higher food prices.
“I think this is why today’s PPI reading came in quite a bit above expectations.”
This is what I received in my morning reseach package…
Good Morning:
At least temporarily, inflation readings will suggest some deflation risk. Yesterday, headline import prices fell sharply. Today, PPI ex food edged down. Core readings gains (ex food and energy) have decelerated. The core crude material prices leads EPS growth and suggests 2Q and probably 3Q earnings will be disappointing.
13. July 2012 at 11:35
Ho ho…
http://www.npr.org/blogs/money/2012/07/13/156705409/the-european-central-banks-guide-to-influence
The Fed is doing the same thing, we’d all be better off if they said out loud the kind of anti-Democrat policy changes they require.
13. July 2012 at 13:59
Re: President Hoover. Few president-elects have been more active and effective philanthropists, innovative inventors, successful industrialists and administrators, and more successful internationalist (in philanthropy, business and diplomacy). I don’t know any prior president who was less of a racist. If any president-elect has been Hoover’s equal in one of these fields, none could compete half as well in the sum of his interests.
There is an important lesson from Hoover’s awesome, titanic accomplishments and the presidency that followed. There is also a important lesson in Oedipus Rex and in Michael Jordan’s baseball career.
PS: Did the real Bruce Bartlett just call a group of people “whores” because of their policy views? I hope not.
13. July 2012 at 19:02
“Remember how a commodity shock in oil in 2008 delayed badly needed Fed action in 2008?”
No, I don’t. Fed cut the short term rate 3.25% between 9/07 and 4/08, and 1.75% post Lehman.
At its first post-Lehman meeting the Fed refused to cut rates but held them stable — citing risk of inflation, due to oil and commodity prices.
This was two months *after* CPI price deflation had started, with deflation running at a 8.2% annual rate July to December.
13. July 2012 at 21:12
FOMC, Sept 16, 2008: “INFLATION OUTLOOK REMAINS HIGHLY UNCERTAIN”
MSNBC, Sept 12, 2008:
“HURRICANE IKE BRINGS SPIKE IN GAS PRICES
As Hurricane Ike bore down on one of the world’s largest concentrations of oil refineries, workers scrambled to shut down production and join hundreds of thousands of residents evacuating the area.
The resulting spike in gasoline prices could be short-lived if damage is light. BUT THE LONGER-TERM IMPACT WON’Y BE KNOWN UNTIL THE STORM PASSES AND FLOODWATERS SUBSIDE. [i.e., the inflation outlook is highly uncertain]
After high prices forced consumers to find ways to conserve, demand for gasoline has fallen steadily this summer “” and prices had been following the same downward trend. But this year’s hurricane season is putting a crimp in supplies that has sent pump prices surging again.
A shift in Ike’s path Thursday “” into a heavy cluster of Gulf Coast refineries “” sent gasoline futures surging by 11 cents a gallon, to $2.86 a gallon. Along the Gulf Coast, wholesale prices skyrocketed to nearly $5 a gallon, up from $3 to $3.30 on Wednesday, according to Tom Kloza, publisher of the Oil Price Information Service.”
http://www.msnbc.msn.com/id/26676331/ns/business-oil_and_energy/t/hurricane-ike-brings-spike-gas-prices/
13. July 2012 at 21:52
MF: Where are the micro-economic factors? Where are the possible subjective preferences and exigent circumstances? I feel like I’m reading a home builder who believes every problem in the house can be solved by using the same hammer with the letters “NGDP leveler” printed on it.
I used to sound like you, only a bit like you I hope. But there is a hammer, it’s called money. And it is in short supply. And only money is like that. It’s different, as you WILL realise if you keep coming to this blog. I predict it.
13. July 2012 at 22:23
as you WILL realise if you keep coming to this blog. I predict it.
Ample evidence indicates this is an irrational expectation.
13. July 2012 at 23:02
James in London:
I used to sound like you, only a bit like you I hope. But there is a hammer, it’s called money. And it is in short supply.
You don’t know it is in short supply unless you base such a judgment on an economically sound, not-opinion oriented standard.
If I told you that 3 Ghz Dell PCs are in “short supply”, then presumably you would probably ask me “short supply…according to what standard?” If I said there should be double the investment in 3 Ghz Dell manufacturing, and double the output, then it is almost a certainty that Dell would suffer tremendous losses. This is because they would have to outbid other producers for scarce factors of production to too high a level which of course would generate costs greater than what consumers are willing to sacrifice from their other purchases in order to pay Dell for the PCs in question, and so Dell would incur losses.
The market process tends to balance each industry in accordance with the relative marginal utility scales of individuals. Most individuals are willing to buy only one or two PCs for their home, and before they buy another they’ll want more of other things first.
So if I said “3 GHz Dell PCs are in short supply”, then a sound economic standard will enable me to know whether or not I made a correct statement. I can know whether or not 3 Ghz Dells are in short supply by referring to the profit earned on the current investment in 3 Ghz Dell PCs. If profits are now, or are expected by entrepreneurs to be, abnormally high, then investors are justified in devoting more capital to Dell PC manufacturing. If on the other hand profits are, or are expected to be, abnormally low or negative, then investors are justified in reducing investment and thus reducing the supply of Dell PCs.
This is how I know how much of something there “should be.” It’s the same exact thing for money. Unfortunately, money in our economy has been forcefully monopolized by the state, and the Fed doesn’t operate according to private property rights subject to profit and loss. They do not produce more money when profit making in money production is relatively higher than other commodities, and they do not produce less money when profit making in money production is relative lower than other commodities. They don’t do this because this information does not exist. The Fed’s owners can print as little or as much as they want, and they will not incur economic losses if they produce too much, and they will not incur profits if they produce the right amount. So they are acting blindly.
That is precisely why this blog exists. We don’t see blogs whose administrators are politically agitating for 5% annual Dell PC growth, because the market process is deciding how many Dell PCs should be produced. It is because there is no market process involved in money production at the Fed, that arbitrary 5% growth rates in aggregate spending are proposed. Why not 5.5%? Or 6%? Or 4.4%? Why 5% even?
I hold that the Federal Reserve should be abolished, and that money production should be carried out by the market process. THEN you can know whether your completely arbitrary, non-scientific opinion that “money is in short supply” is actually correct.
And only money is like that. It’s different, as you WILL realise if you keep coming to this blog. I predict it.
Don’t bet on it. I know that only market based information, of private property economic freedom subject to profit and loss, can tell us how much of a good that is used in catallactics there “should be.” I don’t this conviction changing anytime soon. I will not join this weird Sumner cult that has developed around his unscientific political strategizing.
13. July 2012 at 23:42
This chart is reason number 2748 that Bernanke econ 101, and positivist economic methodology in general, is an utter failure:
http://i.imgur.com/k0i19.png
Flows into equity has contracted back to 1996 levels.
Note: “LO equities” means long only equities.
——————
I just discovered Antal Fekete, and he has a devastating piece that demolishes the crap coming out of Monetarist and Keynesian halls these days:
http://www.financialsense.com/contributors/antal-fekete/2011/12/30/mainstream-economists-monetary-insanity
To wit:
“Friedman’s analysis of the Great Depression couldn’t be more wrong. In 1933 deflation was brought about not by the gold standard but, au contraire, by abolishing it. Here is what actually happened. Roosevelt has removed the only competition government bonds have, gold. The most conservative investors saw their gold confiscated and, willy-nilly, they were forced into the next most conservative instrument, Treasury bonds. Speculators became emboldened and bid bond prices sky high for risk free profits. Had gold been still available, bondholders would have severely punished the speculators for their daredevilry. They would have sold the overpriced bond and stayed invested in gold until bond prices came back to earth from outer space. Then they would have bought their bonds back at a profit.”
“In the absence of gold, speculators made interest rates go into a tailspin. That caused dominoes in the commodity market fall. Prices collapsed one after another. Pieces on the chessboard started falling as well, symbolizing serial bankruptcies of productive enterprises. Breadwinners of families lost their jobs in droves as money flowed from the commodity market to the bond market in the wake of speculators selling commodities short while buying bonds hand over fist. All the while Keynes was rubbing his hands together behind the scenes exactly like Mephistopheles had in the famous paper money scene of Göthe’s Faust (Part Two).”
“The same thing is happening all over again. When a central bank increases the monetary base three-fold in three years, this is a clear invitation for bond speculators to move in and make a killing. But what the central bank utterly fails to understand is that, contrary to its hopes, new money is not going to the commodity market. Speculative risks there are far too great. Instead, new money is going to the bond market where the fun is. Bond speculation is risk-free. Speculators know which side the bread is buttered. Krugman doesn’t.”
13. July 2012 at 23:43
“The fact is that central bank buying makes speculation risk free in the bond market. In comparison, speculative risks in the commodity market appear forbidding. All the speculator has to do in order to reap risk-free profits is to preempt the Fed. He buys the bonds before the Fed has a chance. Then he turns around and dumps them into the lap of the Fed at a profit. The Fed is helpless: it must buy at the higher price. Keynes completely misrepresented the ability of the central bank to stay in charge, given its compulsive drive to suppress interest rates when confronted with a profit-hungry pack of bond speculators.”
14. July 2012 at 06:21
Johnleemk, Good point.
Rebeleconomist, I don’t recall it even happening, as I wasn’t watching Japanese interest rates at that time. But I don’t know how you can claim we don’t yet know if it was a mistake. Japanese NGDP has since fallen by 7%, even Hayek would say that’s too tight. What more evidence would you need that it was too tight? What metric would you use to show when policy is too tight?
dwb, I meant the median economist had the wrong policy views, I didn’t mean to suggest the median economic forecast was wrong.
bababooey, I agree with all of your points.
James of London, I appreciate the support, but I predict your prediction about MF will be wrong.
14. July 2012 at 06:27
Scott N, Thanks. That was reasonable, but somewhat wishy washy.
14. July 2012 at 09:31
Scott, unfortunately we will never know whether the decision to start unwinding QE in Japan was a mistake, because not long afterwards, they got pitched back into recession by a financial crisis that was not of their making. However, the fact that real GDP growth in 2007 was quite respectable at 2.4% does suggest that ending QE was not the cause of Japan’s renewed downturn.
As I have said here before, Japan’s problem is not monetary policy, but a failure to clean up the problems after its bust, as the continuing emergence of these problems, such as recently at Olympus and AIJ, demonstrates. But of course, politicians are reluctant to make people face up to their mistakes when there are softer alternatives being peddled by plausible academics. I’d wager though that this mistake that seems obvious to me, that will condemn millions of people to needless economic stagnation, doesn’t even register in your consciousness.
14. July 2012 at 10:16
James in London,
I can actually remember when you were mostly skeptical of what Scott was saying. Scott may not be the best writer, but he certainly keeps at it — now if only we could convince the median economist!
14. July 2012 at 10:51
Alan Meltzer in a recent editorial in the Wall Street Journal has asserted that:
“To his credit, Mr. Bernanke did not immediately agree. But he failed utterly to state the obvious: The country’s sluggish growth and stubbornly high unemployment rate was [sic] not caused by, nor could it [sic] be cured by, monetary policy.”
I do not have access to the editorial and have taken the quotations from Glasner’s UNEASY MONEY site at
http://uneasymoney.com/2012/07/10/murdoch-tends-to-corrupt/
Also at this site:
“Now what is Professor Meltzer’s evidence for the Fed’s impotence? Let him speak for himself: Market interest rates on all maturities of government bonds are the lowest since the founding of the republic.”
and
“Meltzer asserts that the cause of the weak recovery is uncertainty about future tax rates, health-care costs, and the regulatory burden.”
It is clear that Meltzer cannot be considered a monetarist any longer by any reasonable definition. In order to further the right-wing party line that uncertainty about future tax rates, health-care costs, and the regulatory burden are what is keeping the economy depressed he has turned his back on all of the main tenents of monetarism.
14. July 2012 at 11:06
“The Fed is doing the same thing, we’d all be better off if they said out loud the kind of anti-Democrat policy changes they require.”
Morgan, once again, is right on about what the Fed is up to. The FOMC is clearly trying to use monetary policy to impose right-wing economic policies on the U.S. government. This is why Obama’s reappointment of Bernanke is his most serious policy blunder. And the failure to make sure that he only appointed people to the BOG who were strongly comitted to upholding the Fed’s mandate to achieve maximum employment was another major blunder.
And the FOMC, in blatently refusing to comply with its Congressional mandate to achieve maximum employment is sabotaging Obama economically. One can dispute about whether this is intentional or not, but there is no question about the fact that it is doing it.
14. July 2012 at 11:30
Meltzer: “To his credit, Mr. Bernanke did not immediately agree. But he failed utterly to state the obvious: The country’s sluggish growth and stubbornly high unemployment rate was [sic] not caused by, nor could it [sic] be cured by, monetary policy.”
~~~~~
Prices fell from July through December 2008, with deflation running at a 13% annual rate through the fourth quarter.
How does one get 13% deflation not caused by monetary policy?
I’m particularly interested in how a monetarist explains this.
14. July 2012 at 22:56
Tiresome as MF is to some, it is still a good thing he comes here. It shows how important the site is that he devotes so much time to it. He also represents one common view, the fear of the 1920s hyperinflation. Fear of that drives the average economist too, hence the own letter from 2010.
As Scott has shown, fear of the 1920s caused the 1930s. It’s a paradox, but that is what I have learned here about money, as the intro to this blog site states. I actually share many of the Rothbardian prejudices of MF, but have always been puzzled and frustrated with MR for not discussing the 1930s except as the path to WW2. I loved Rothbardian on that terrible story, but his history and theory of the Great Depression was never written.
Actually, Friedman and Schwartz wrote it. When MF rages about leaving money to the free market, as Rothbard would have done, he has to think what monetary policy would a successful private sector money company follow if face with a shock to the economy? What would The Bank of Major Freedom do? What would the Bank of James in London do? Thinking about that helped me understand market monetarism, thinking about that might help MF too. And the 2010 letter signatories.
15. July 2012 at 08:47
Rebeleconomist, How can I even respond to you if you won’t tell me what metric you use to show when money is too tight?
James, MF does a real disservice to sound Austrians. He so so misguided about everything that he embarrasses himself. He doesn’t even understand basic economic concepts like comparative advantage, nor does he know how to read data, and understand what he is reading. If I was an Austrian I’d be trying to get him to shut up. But I’m not an Austrian.
Your last paragraph is a really good point.
15. July 2012 at 14:32
How can you tell when money is too tight? That is an interesting question, Scott. The conclusive sign would be that there is signficant (in the Greenspan sense of being a factor in household and business decisions) deflation. However, an earlier warning should be provided by the price of what the central bank buys to supply money – if the price of what the central bank buys is falling despite an increase in the rate of money supply, that suggests that the central bank is failing to meet an increased non-transaction demand for money.